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Diamond ETF: An Investor's Best Friend in 2013?

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The new Diamond/Gemstone ETF from upstart PureFunds is off to a solid start since its recent debut. The product has easily beaten out broad markets and mining focused funds as well in its short time on the market.

In fact, the new ETF has beaten out (XLB - ETF report) by about 1,000 basis points in a little over a month, while its performance against (SPY - ETF report) has been even similar, leading that floundering index as well. If that wasn’t enough, GEMS has also seen even greater levels of outperformance against ETFs that mine for precious metals like gold or silver, suggesting that trends could be lining up for GEMS and the diamond industry as we get further into 2013.

This is because of some bullishness in the overall diamond space and a growing imbalance in the supply demand picture. This has been further compounded by rising demand in enormous emerging markets, specifically China and India, which are just now starting to develop an appetite for participation in the diamond market both from a jewelry and an investment perspective.

After all, some estimates suggest that China and India account for just over 12% of global diamond demand now, but that they could account for nearly 50% of demand by 2025. Clearly this could be a huge new source of fresh demand even if we see flat growth in the rest of the world (read Access the $30 Trillion Consumer Market with These ETFs).

Supply & Demand

Global demand is increasing 5.9% annually through 2020, but supply is only moving higher by about 2.7% a year over the same time period. Add in the extreme difficulty in finding new supplies—some believe that ‘peak diamond’ has been reached already-- and the lack of new mines coming online, and investors could see a continued bullish trend in the space this year.

Further good news just hit the market in the space thanks to Swatch buying Harry Winston’s retail unit. This will leave Harry Winston —which will soon be called Dominion Diamonds—focused in on the diamond mining business which has seen higher margins in the recent past (see Top Three Precious Metal Mining ETFs).

The firm has already stated that it is considering diamond mining acquisitions, so this move could give them some added capital to explore this avenue. This could be another positive move for the industry as well, as it could signal a new M&A trend that may put a modest premium on some of the smaller players in the space, especially if it appears as though some acquisitions are imminent.

Diamond ETF in Focus

Despite some of these promising trends and the incredible start for the Diamond and Gemstone ETF, GEMS is still a relative unknown to many investors. For this reason, we look at some of the key aspects of this ETF below, for those who are looking to take advantage of the interesting situation developing in the diamond and gemstone market in 2013:

GEMS tracks the ISE Diamond Gemstone Index and holds about 23 stocks in its portfolio, with an overwhelming focus on diamond production and finishing. Some gemstone producers also make their way into the ETF, but their exposure pales in comparison to the diamond-focused components (also see Palladium ETFs to Rally in 2013?).

Individual holds are well spread across nations and across continents, although there is a focus on Canadian and British securities, and stocks based in Hong Kong. Exposure is also tilted towards small and mid caps, but some large caps like Anglo American and BHP Billiton (BHP - Analyst Report) make their way into GEMS as well, largely thanks to their massive levels of production of gemstones (BHP Billiton) or their outright ownership of key diamond players (Anglo owns 85% of DeBeers).

Investors should also note that volume in the product isn’t exactly great right now, so you could see some relatively wide bid ask spreads. However, in recent looks, the spread was only a few basis points wide so it shouldn’t add too much to the stated expense ratio of 69 basis points a year (see PureFunds Debuts Innovative Mining ETFs).

Still despite this drawback, the ETF has been a very solid performer in its limited time on the market and it remains the only way to gain targeted exposure to the diamond industry in ETF form. For this reason, GEMS could be an interesting pick in 2013 for those looking for a new hard asset play that goes beyond the traditional markets and into something potentially even rarer than precious metals that also has strong fundamentals at its back.

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